While trend-following investments can provide downside protection, allocators get a boost when they add strategies focused on short-term trends, according to the latest research from Man AHL, an investment management firm based in the U.K.
What exactly does “short term” mean? According to the company, investors should look for market trends that last for a couple of weeks, rather than months or longer.
In their latest piece, Man AHL researchers compared the performance of a few hypothetical portfolios, each of which combined traditional stock-and-bond portfolios with trend-following strategies trading at different speeds.
The slowest strategy, which had a trend-length sensitivity of 24 weeks, offered the weakest protection during drawdown periods from 1995 to 2022. On the other hand, portfolios that included strategies as short as four weeks went down the least during historical market downturns, according to the piece.
“Compared to a slower system, [a faster one] helps protect traditional portfolios in terms of downside mitigation,” Adi Mackic, senior client portfolio manager at Man AHL, told II in an interview. “A slower system…is not able to adjust its position [quickly] because it has a longer horizon [to look back on].”
Mackic added that investors don’t have to allocate only to short-term trends. But they should at least consider splitting investments across trend-following strategies that unfold at different time frames to obtain more diversification.
“To our knowledge, very few investors own [nothing but] trend-following strategies. Instead, they tend to be used as part of a portfolio,” Mackic wrote in the paper. “If the aim of the trend-following allocation is to boost the defensive properties of a portfolio, then perhaps a more responsive system, [one that allocates] more to fast-trend models, may suit best.”
Trend-following strategies in general had a good run in 2022. The SG Trend Index, which monitors the ten largest managed futures funds, was up 36 percent in the first three quarters of 2022, while the conventional 60/40 stock and bond portfolio lost 20 percent. According to quant manager AQR, the strategy will continue to outperform as macroeconomic uncertainties continue to mount.
Man AHL is also optimistic about the outlook for trend-following strategies. “[We’re in] an environment that trend-following likes,” said Graham Robertson, head of client portfolio management. “Large moves in markets associated with inflation [are] something that...trend-following strategies have [historically] enjoyed.”
“They don’t really care whether the market will be up a lot or down a lot. The fact that the market moves at all gives them the ability to [outperform],” Robertson concluded.